White House's Dollar Dilemma:
Weak Currency Helps Economy

MICHAEL M. PHILLIPS and MICHAEL R. SESIT / Wall Street Journal 13may03

Snow's Remarks Push Down Greenback Against Euro, Raising Questions on Policy

The dollar fell to a four-year low against the euro, underscoring what is becoming a central economic dilemma for the Bush administration: A weaker dollar may help give the U.S. economy a welcome boost, but it could be risky to say that out loud.

That predicament became clear Monday when comments by Treasury Secretary John Snow convinced financial markets that the Bush administration secretly welcomes the dollar's decline. Mr. Snow's seemingly innocuous statement Sunday -- that a weaker dollar helps American companies compete internationally -- drove the already-weakening currency lower against against the yen as well.

The struggling U.S. economy is at a point where it benefits from both a weaker dollar and a stated government policy favoring a strong dollar. The weaker buck makes U.S. goods cheaper to foreign consumers and combats deflation by pushing up prices of imports. But strong-dollar rhetoric helps keep markets calm and discourages a potentially disastrous free fall in the currency.

Before settling at $1.1543 in late New York trading, the euro touched $1.1625, its highest level since Jan. 19, 1999. The European currency had traded at $1.1495 late Friday. Meanwhile, the dollar also weakened1 against the Swiss franc, Canadian dollar and Australian dollar. Stocks, however, rose2.

LOSING CURRENCY

The Treasury secretary's comments "reinforced the belief that the U.S. administration is content with the [dollar's] current depreciation," said Aziz McMahon, a foreign-exchange strategist at ABN Amro Bank in London.

The dollar's recent movements are likely to be a hot topic of discussion -- at least informally -- when Mr. Snow meets Saturday in Deauville, France, with his fellow finance ministers in anticipation of the Group of Eight Summit next month. While the Bush administration may be quietly enjoying the greenback's slide, the Europeans and Japanese are concerned that it is cutting into their exports at a time when their domestic economies are weak.

Giant European companies, from Volkswagen AG and Nokia Corp. to Akzo Nobel and Michelin, are complaining that the strong euro is hurting their financial performance. Many companies in the euro zone have cited the strong currency as a reason for lower-than-expected first-quarter profits.

Mr. Snow, who was supposed to be a smoother-talking replacement for the famously loose-lipped Paul O'Neill, isn't yet fluent in the delicate language of dollar policy. Despite advice from underlings, he still strays from the script.

Responding to a question Sunday on ABC's "This Week," Mr. Snow said: "When the dollar is at a lower level it helps exports, and I think exports are getting stronger as a result."

"What he has done is stated one of those obvious truths that the secretary of the Treasury isn't supposed to say," said Princeton University economist Alan Blinder, a former vice chairman of the Federal Reserve Board. "When the secretary of the Treasury says something like that, it gets imbued with deep meaning, whether he wants it to or not."

Treasury and the White House quickly tried to undo the damage. "The dollar policy remains unchanged," Treasury spokesman Tony Fratto said Monday.

Mr. Snow "knows the position is support for a strong dollar," White House spokesman Ari Fleischer told reporters flying with the president to Omaha. "Obviously exports depend on a variety of factors."

But the markets weren't so easily persuaded. "If the weak economy weren't enough, Treasury Secretary John Snow's weekend remarks gave traders another excuse to sell the dollar," the G7 Group, a political and economic research firm, told clients. By noting the obvious connection between exchange rates and U.S. exports, "he sparked fear that the U.S. government might actually be interested in engineering a weak dollar to help bolster the flagging economy."

The U.S. current-account deficit -- the broadest measure of America's trade gap -- is near a record 5% of gross domestic product, meaning Americans are buying imported goods on money borrowed abroad. So far, flows of foreign investment into the U.S., especially Treasury and corporate bonds, are holding up reasonably well. And the recent decline in long-term interest rates set in the bond market suggests that the dollar's weakness isn't yet spooking investors.

But a rapidly falling dollar would make those assets significantly less appealing for foreign buyers, who count profits converted into their own currencies. The fear of a dollar slide would lead foreigners to demand a bigger reward -- higher interest rates -- for putting their money in dollar-denominated assets. Higher interest rates would be unwelcome when U.S. growth is so disappointing, and a falloff in capital inflows could push the dollar even further down.

Currency traders monitor every word the Treasury secretary utters about the dollar. Former secretaries Robert Rubin and Lawrence Summers had a standard refrain about the strong dollar being in the U.S. interest. It was a truism when it kept inflation in check without causing much damage to U.S. manufacturers enjoying the domestic boom. Mr. O'Neill, President Bush's first Treasury chief, stirred markets by improvising about the dollar until he, too, decided to stay with the mantra.

When Mr. Snow came into office, he and White House officials huddled to decide what his approach should be. They chose to toe the Rubin-Summers line in part to give the new secretary credibility in the marketplace. He would say that the strong dollar is in the interest of the U.S. economy, and that strong economic policies and free markets are the best way to allow the currency to find its value. Since the U.S. policy is to promote a strong economy, that should result in a strong dollar.

Despite the Treasury's assertions to the contrary, some traders still see Mr. Snow's comments as a signal that the administration would happily accede to an even lower dollar. Economically, a weaker dollar makes a good deal of sense right now. The U.S. economy is growing only slightly, if at all, and a weaker dollar would help American manufacturers sell more abroad, and fend off foreign competitors at home. In addition, the Fed last week warned that the risk of deflation, however small, is greater than the risk of inflation, the first time the central bank has sounded that alarm. A weaker dollar helps fend off such a debacle by pushing up import prices.

The U.S. could intervene on the foreign-exchange markets to prop up or weaken the greenback. Less likely, the Federal Reserve could manipulate interest rates to affect the currency. So far, Mr. Snow seems to be relying on only rhetorical devices.

"I think he chose his words carefully," said Jason Bonanca, currency strategist at Credit Suisse First Boston. "While he's not willing to see a rout [in the dollar's value], the depreciation over the last several months and last several weeks has not been a cause for concern."

Traders said the dollar, which declined slightly against the yen, would have fallen more steeply were it not for their fears that Japan would intervene in currency markets to halt the dollar's fall, and the yen's rise. Last week, Japan released data showing that Japanese authorities in the first quarter had spent ¥2.38 trillion yen ($20.36 billion) buying dollars and euros.

-- Bob Davis in Washington and Spencer Jakab in London contributed to this article.

After years of strength, the dollar has been in a downward spiral since early 2002 against most major currencies, most notably the euro. In the last few days, the selloff has picked up momentum, with the euro hitting $1.1543 in 4 p.m. trading Monday, the highest close in New York trading in over four years.

The Bush administration has professed its belief in a strong dollar, but recent remarks by Treasury Secretary John Snow suggesting a weak dollar could help the economy by boosting exports supported the suspicion that the administration's dollar policy is more benign.

Click through to the following panels for an explanation of why the dollar has fallen, what the effects are, and what the future may hold.

Research: Cindy Perman

For years, foreign investors poured money into U.S. equities markets, which pumped money into the economy, on expectations of robust productivity. That gave foreign investors confidence in the rate of return on their investment in the U.S.

But then the stock-market bubble burst, corporate shenanigans unfolded, the economy's recovery sputtered, the Fed lowered interest rates to a 41-year low and the U.S. went to war, eroding that confidence, says David Mozina, head of G10 forex strategy at Bank of America in New York. As a result, yields in overseas markets have been typically higher than the U.S., says Marc Chandler, chief currency strategist at HSBC in New York. When that happens, foreign investors are less likely to invest in the U.S., which lowers the value of the dollar. When investors pull their money out of lower-yielding U.S. bonds for nondollar-denominated investments, it has the same effect as selling dollars.

Americans' appetites for imports has a similar impact. Buying clothing made in China, for example, effectively is the sale of dollars in exchange for goods made of yuan

What Does It Mean... ... for consumers?

- Foreign goods now cost more here, and U.S. companies are under less pressure to keep prices low - The dollar doesn't go as far overseas, so now probably isn't the time to take that European vacation you've been putting off Italy: Then and Now 6/2002 6/2003 Five-star Bernini Bristol hotel in Rome $398 $534 11-day "Enchanting Italy" package with airfare from NYC $2,199 $2,329 "Rome by Night" tour with dinner $59 $63 Source: Gate 1 Travel

... for companies? + U.S. goods become cheaper and more attractive overseas -- good news for the struggling U.S. manufacturing sector

+ For companies with substantial foreign operations (like Coca-Cola which generates 80% of its operating income overseas) money generated abroad is worth more dollars when it is brought back home.

- More expensive for U.S. companies to set up operations overseas

... for investors?

+ A falling dollar can amplify gains earned on foreign stocks. For instance, if a stock traded in Milan rises 10% and over the same period the euro gains 10% against the dollar, an American selling the stock would benefit from the price appreciation, as well as from translating the euros from the sale to dollars.

- Might stall market's recovery if confidence in the U.S. economy fails to recover and derails foreign investment ... for the economy? + Helps address the Federal Reserve's concern about deflation, or falling prices, by taking the pressure off U.S. companies to keep prices low

- Too much inflation could drive up interest rates, hurt the standard of living and ultimately curb economic growth.

+ More foreign tourists can afford to visit the U.S.

What's Next?

Some economists say that the dollar's value was too high and that a moderate pullback is healthy. Nevertheless, a continued decline in the dollar could further erode confidence in the U.S. economy.

The European Central Bank has made it clear that it sees nothing "excessive" about the euro's current level and therefore isn't likely to intervene in the near term. The opposite is the case with the Bank of Japan, which has expressed willingness to intervene to keep the yen's strength in check.

Last week, Goldman Sachs -- which for years had been expecting a decline in the dollar -- upgraded its euro forecast, calling for the currency to climb as high as $1.22 in 12 months' time. HSBC pegs the chances of the euro hitting $1.20 this year at 50%. Bank of America also sees the euro in a $1.20 to $1.25 range.

Letting the dollar go lower will lead to an improvement in exports, takes pricing pressures off corporations, and could boost the earnings of American companies that derive a lot of their income from overseas. But the flip side in Europe could prompt companies there to put pressure on the ECB to change its policy.